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An Athenian withdraws euro bank notes from an ATM for the first time, January 2002. (Courtesy Reuters)
The global financial crisis has revealed flaws in the European monetary union that make it seem more like a political construct than a coherent economic project. These problems have proved particularly painful for the peripheral eurozone countries, including Greece, which have found themselves with uncompetitive exports and massive debt.
But the euro was a good idea for Greece when the country decided to join, and it can still be saved. As the Greek finance minister from 1994 to 2001, I steered my country into the common currency club -- and to this day, I believe it was the right decision.
Why did Greece seek to join the economic and monetary union? Greece’s economic performance after the oil shock of the early 1970s was poor: it faced slow growth, high inflation and unemployment, huge fiscal deficits, increasing debt, a declining currency, and inadequate infrastructure. The government’s lack of macroeconomic discipline and its tendency to succumb to populist demands and vested interests accounted for much of the country’s economic weakness until the mid-1990s. The restoration of democracy in 1974 consolidated human and political rights and promoted social justice, but it failed to modernize the Greek economy.
In the minds of the country’s progressive elites, entering the economic and monetary union seemed the ideal solution to Greece’s fiscal woes. The theory was that the common rulebook of the eurozone would create a system of carrots and sticks that would induce the political system to pursue longer-term goals such as productivity and employment growth and thus respond to the country’s real needs.
At first, events played out according to plan. During the period of Greece’s accession to euro, from 1994 to 2000, its economy was rapidly stabilized, as both inflation and the fiscal deficit decreased drastically. Businesses and consumers became more confident, investment picked up, and the government put in place a package of liberalizing reforms. Greece’s GDP growth rate jumped from −1.6 percent in 1993 to close to 4 percent in 1997, and stayed at this level until 2007.
Around ten years ago, however, things took a turn for the worse. Athens’ excessive borrowing created a credit bubble, which burst when the global financial crash reversed the positive trends in world economic performance.
What went wrong? A fashionable answer is that Greece was never suited for the eurozone in the first place, and that it needed to falsify economic statistics to secure membership in the club. Indeed, several years after the fact, Greece’s budget deficit for 1999 was revealed to have been higher than the three percent of GDP ceiling required for admission to the euro. But this statistical revision did not owe itself to deliberate falsification; it was rather the result of arbitrary and politically motivated changes in accounting methods. It was as if a new CEO took over a company and changed profitability rules so that past performance looked like failure.
Greece’s problems, then, did not arise during the accession process; they began midway through the last decade, when large imbalances emerged between eurozone countries. The competitiveness of the peripheral countries, particularly Greece, Ireland, Italy, Portugal, and Spain, deteriorated sharply compared with that of the core countries. Governments on the periphery turned a blind eye to the accumulation of public and private debt, building up massive deficits while the northern Europeans were running surpluses. The excess savings of the core were transferred to the periphery in the form of credit, which in the event of the financial crisis created the threat of sovereign defaults and a potential breakup of the monetary union.
It is true that some of these problems were the result of fundamental weaknesses in the eurozone’s makeup. Because the eurozone is an incomplete monetary union, its less competitive economies can neither bolster their exports by devaluing their currency nor rely on a supranational lender of last resort.
Still, Greece’s woes were not an inevitable result of its joining the euro. Athens could have avoided them by pushing for fiscal consolidation, so as to pay down its debt, and making the kind of reforms that would have boosted its productivity and competitiveness. Instead of falling into the fiscal laxity and inertia on reforms that began to characterize Greek policy, the country should have continued to liberalize and privatize its economy while speeding up the modernization of the state.
Resolving the crisis will require action both on the eurozone level and in national capitals. The over-indebted countries must reduce their deficits and strengthen their competiveness by liberalizing their economies and encouraging wage flexibility. Cutting down government waste, combating widespread tax evasion, and abolishing restrictive practices in the economy are necessary to make the euro work for Greece. At the same time, at the eurozone level, the monetary union should be expanded to become a full-fledged economic union, with common fiscal and financial institutions.
The policies that the eurozone has initiated to tackle the debt crisis have been inadequate and even self-defeating. The debt-ridden countries have been forced to stomach exceptionally harsh austerity measures, including tax increases and cuts in public-sector salaries and pensions. These could have been avoided had the peripheral countries implemented structural reforms, in particular privatizing state-run enterprises, opening up closed professions, and downsizing the government sector.
Leaders on the eurozone level only made matters worse by failing to promote measures that might have made up for the negative effects of austerity on demand. Germany refused to take advantage of its stronger fiscal position so as to adopt more expansionary policies and better aid the peripheral economies. The European Central Bank, meanwhile, has not eased monetary policy to the extent required for boosting inflation in core countries and thus helping close the competitiveness gap with the periphery.
The pursuit of structural reforms on the periphery will not be easy. Greece, for example, has for the last several years opted to spread misery horizontally through austerity rather than confront the special interests that block reforms. These include businesses in protected markets, such as electricity, and public-sector trade unions. The reform agenda is likely to move slowly on the eurozone level as well, because it touches on sensitive issues including the allocation of resources within the monetary union and the transfer of sovereignty from national to European institutions.
Can Greece survive in the eurozone? That depends on whether the country’s political system finds the strength to make reforms and whether the eurozone reshapes its policies by adopting a growth agenda and moving more boldly on the road to unification. On both fronts, there is reason to be pessimistic. Greece’s political system, despite the emergence of a reform-oriented government after last June’s elections, appears fractured and weak. Meanwhile, the approach of German parliamentary elections in the fall is likely to postpone any difficult decisions at the eurozone level, since Berlin will be reluctant to make any more far-reaching commitments.
Nonetheless, the consequences of Greece’s exit from the eurozone would be disastrous for both the country and Europe as a whole. The ensuing instability would cause a sharp decline in Greek living standards, and Athens, without pressure from above, would lose much of its incentive to press forward with crucial reforms. A tear in the monetary union, moreover, would undermine the cohesion of the remaining eurozone members. If the promise of a more perfect union does not encourage Europe to make the necessary fixes, the fear of the alternative should do the trick.